CNBC - Krystina Gustafson - 14 March 2017
Things are about to get even harder for distressed retail chains thanks to rising interest rates.
After years of low rates fueled a private equity "feasting" on retail firms, the number of troubled chains has tripled over the past six years, and is now at its highest level since the Great Recession.
Moody's Investors Service says that 19 of these companies have "well over" $3.7 billion in debt that matures over the next five years. Roughly 30 percent of that total is due by the end of next year.
The timing for higher rates couldn't be worse. Revenue continues to tumble as the debt maturities swell.
Though credit markets have so far remained strong, allowing many retailers to proactively refinance their debt, Moody's warns that rising U.S. interest rates could abruptly change those conditions. The Federal Reserve is expected to raise rates three times this year, with the first such move anticipated on Wednesday.
"If interest rates do go up it's going to be harder for them to find more favorable options," Murali Gokki, a managing director in AlixPartners' retail practice, told CNBC. "The clock is ticking."
The 19 distressed retailers on Moody's list have already been pummeled by a confluence of headwinds, including fierce competition from Amazon, T.J. Maxx and Zara. The growth of these chains has contributed to oversupply in the U.S., which started during a period of overexpansion in the 1990s. That, in turn, has caused many companies to compete on price.
Distressed chains' ailments have become even more acute as consumers buy fewer tangible goods and opt to travel and dine out.
"It's putting a lot of stress on a number of retailers as they try to figure out how they can profitably invest and compete," Michael Brown, a partner in A.T. Kearney's consumer products and retail practice, told CNBC. Those types of fundamental weaknesses are a bigger threat to distressed retailers' survival than gradually higher interest rates, he added.
Revenues at Sears, for example, continued their precipitous decline in the fiscal fourth quarter, forcing the retailer to sell off assets and borrow money to avoid what many consider an inevitable bankruptcy filing.
At several distressed retailers, the troubles can be traced back to leveraged buyouts, when private equity firms used a combination of equity and debt to acquire them. Teen accessories shop Claire's and apparel chain J.Crew are two such names where sales decreases have been coupled with high levels of debt from these types of transactions.
Reversing revenue declines is a big challenge for distressed retailers, who lack the cash to invest in their businesses. Often, these companies' knee-jerk reaction is to slash prices on their merchandise, which further erodes profitability.
"It's a tough period of time for these guys right now," Moody's analyst Charlie O'Shea told CNBC's "Power Lunch."
Meanwhile, more financially sound competitors are looking to take advantage of distressed chains' weaknesses. As a slew of sporting goods stores fall by the wayside, Dick's Sporting Goods is opening new locations. At J.C. Penney, CEO Marvin Ellison's turnaround plan includes muscling in on appliances and installation services, two categories that Sears once dominated.
And Target chief Brian Cornell said his company's $7 billion capital investment into better stores, digital upgrades and exclusive merchandise is meant to ensure the company "win share, not surrender it."
"Many of our competitors are aggressively rationalizing their assets," Cornell said at the company's investor day in New York City last month. "They're cutting costs just to keep their heads above water. ... This contraction will create opportunities for Target to pick up market share over the long term."